If you are planning to form a trust to hold foreign property or managed by a foreign trustee, you may wonder if California trusts are taxed differently than trusts formed in other countries. Unfortunately, there is no simple answer to this question. If your trust has any cross-border involvement, you need to speak to tax and estate planning professionals about how to proceed.
There are many factors that affect the tax treatment of trusts, including but not limited to:
- Residency of trustees
- Whether a foreign resident trustee can control decisions about the trust
- Location of assets held by the trust
- Language in the trust document regarding where the trust will be administered
- Where the trust is actually administered
- Whether the trust is a grantor trust or non-grantor trust (a legal determination)
The first step in determining how the trust will be taxed is evaluating whether it is a “domestic” or “foreign” trust. Each receives different federal tax treatment. Determining the proper category is very complicated. Trusts can even switch from domestic to “accidental” foreign trusts by something as simple as changing the trustee to a non-U.S. citizen.
In addition, you will need to figure out how the trust is taxed in California. California has different rules than some other states for trust taxation. State law looks to (1) whether the trust crosses borders (by holding foreign property or having a foreign trustee), and (2) whether the trustees and non-contingent beneficiaries are California residents. If a trustee is a California resident, the trust must pay California taxes. If the non-contingent beneficiaries are California residents, then the trust must pay California taxes. This is true even if the trust holds no property located in California.
As you can see, determining where a trust will pay taxes and which taxes it will pay requires answering a number of questions and interpreting complicated tax laws. The location in which a trust is formed may not matter at all. Many different factors do matter and could greatly affect the amount of taxes that you pay. In fact, your trust could accidentally change from a domestic to foreign trust or the reverse without you knowing. Talk to an experienced and knowledgeable estate planning attorney when you set up the trust and before you make changes to the trust to learn about tax treatment.
Planning to form a trust that holds foreign assets or has a non-U.S. citizen trustee? Look to Janet Brewer, Esq. for thorough and thoughtful estate planning advice. Janet has more than 20 years of legal experience and is certified as a California estate planning and probate specialist by the California State Bar Board of Legal Specialization.
To schedule a “Get Acquainted” meeting, visit Janet's website or call her office at (650) 469-8206.